Learn how to calculate equity.
The house of justice. It’s what makes home ownership (and all the ups and downs that come with it) worth it. Owning your own home means that all of your mortgage payments are finally paying off, and you’re building wealth while enjoying one of the largest investments you’ll likely ever make.
You may not think much about your home ownership on a daily basis, and that’s all well and good. But if you find yourself in a position where you want (or need) to move out and buy another home, you can bet you’ll quickly ask yourself, How much equity do I own in my home?
What are real estate property rights?
When you sell your home, you will have to pay the unpaid portion of your mortgage to the bank. This is easy to do if your home has gone up in value over the years since you first took out the loan. If that’s the case, you’ll have excess funds — or home equity — at your disposal. Home equity is the amount you paid to own your home.
If you don’t have equity, it becomes much more difficult to get the funds to pay off an existing mortgage, let alone a down payment on the next property you have your eye on. Let’s look at two very different examples.
The Joneses decide they need a much larger house to live comfortably. Their current home, which they paid $385,000 for, is only worth $380,000. Since their loan was an interest-only loan, they’ve paid $0 towards the principal balance since moving into their home five years ago.
Jones Equity = – $5,000 ($380,000 Value – $385,000 Loan Balance)
Assuming they sell the house at its current price, not only will they owe the bank the remaining $5,000, but they must make the down payment for their new home from savings or elsewhere.
The smart family is moving to a different city and you will need to buy a new house. Their current home, which they paid $385,000 for, is worth $390,000. The family also put down $20,000 on the house and paid off $85,000 of their principal balance — bringing their loan balance to $280,000.
Smart Family Equity = $110,000 ($390,000 value – $280,000 loan balance)
Obviously, a smart family will be in a much better financial position when it comes time to buy a new home. As shown in the Jones family example, without equity, you’re stuck with a diminishing asset (essentially a drain on money) said Ollie Watson, a real estate agent with Dwell.
He added, “Given that negative or meager real estate ownership is usually the result of stagnant or declining home prices, this can become a vicious cycle for homeowners as they are unable to move and also lose money on their existing homes.”
How do you calculate home ownership?
Are you hoping to avoid a situation like that of Jones above? It helps to have an understanding of how home equity is calculated if you’re wondering, “How much equity do I own?” As the examples above show, calculating how much equity you have in your home is as simple as subtracting the remaining mortgage balance from the appraised value of your home. So, for example, if your home is worth $400,000 and you owe $100,000 on it, you have $300,000 of equity in your home. In this case, if you decide to move, you’ll take the first $100,000 to pay off your loan, and then you’ll have $200,000 to put towards the purchase price of the new home.
Another term you may hear when discussing equity is loan-to-value ratio, or LTV. According to Watson, this is the ratio of the amount you borrow to finance a home compared to the total value of the home. It is a way for banks to assign a level of risk to the loan they are going to give you. Watson said most banks feel comfortable with an LTV of anywhere between 50 and 90%, which depends on several external factors.
For an LTV account, you need home value, said Andrew Chen, founder of the personal finance site Hack Your Wealth.
Typically, mortgage lenders use the appraised value of a home to determine its value, and then apply a percentage such as 80% to that value to determine the allowable lifetime value of the mortgage loan. This percentage is based on the lender’s lending criteria and standards.
Calculating permanent value
Let’s say you want to buy a $300,000 home but you don’t have any equity to put into that purchase and you save $6,000 just to get rid of. This means your estimated lifetime value is 98% – you’ll be financing 98% of your home. Most banks would consider this a very risky investment.
However, if you had $130,000 in equity from the home you just sold to put into the same $300,000 home, your assessed LTV would only be 56% (300k to 130k divided by 300k) – It is a safer investment in the eyes of the bank.
How can I increase my home ownership?
There are two basic ways to increase the amount of equity in your home: reduce the amount you owe on the home or increase the value of the home. Throwing extra money into your monthly mortgage payments is the best way to reduce the amount you owe. But fortunately, you do have some options when it comes to increasing your home’s value without necessarily having to pay more for your principal each month.
appreciation in value. Your home may naturally appreciate in value, especially if it’s in an area with healthy growth. This increase turns into equity in your home, because it is an asset you own. Although this estimate is factored into your personal assets, you won’t use it until you go to sell your home (except in the case of a HELOC, or home equity line of credit).
home improvement projects. According to Watson, the best way to increase the value of your home by making changes to it is by building an extension, renovating the space you already have, or remodeling the space you already have.
“Of course, all of these choices cost money and need to be done the right way, so there are inherent risks to each of them. If you are not experienced with renovations, the best course of action is to imitate what people have done in similar homes and neighborhoods to successfully add value to their homes.” .
It is worth noting that not all home improvements are created equal. New custom Shaker-style cabinets, for example, might be more attractive to you, and might be something you might be willing to pay more for in your next home. But when it comes time for a bank-ordered appraisal, they’ll likely add little or no value to the home—which means you’ll be left out of the cost of the investment with no real return.
The point is, if you intend to use renovations to raise capital, consult a professional to determine the best place to spend your money.
Using Your Equity: What is a HELOC?
In most cases, you will use the capital you built in your home when you purchase a new home. However, there is a way to take advantage of it earlier, and that is by getting a home equity line of credit. “Hilock is money that is taken out against the value of your home (like a second mortgage) but can be used for things other than just paying for your home,” Watson said.
Is Hilok a good idea? Watson said it could be in some cases.
“Taking out a HELOC is only a good idea if you are confident that the price of your home can go up to cover the money you are taking in and more. It is especially appropriate if you own property in an area that is suddenly getting rich. This is because the value of your home will go up, and so will your expenses.” A HELOC can help you cover these expenses in the short term, while your property covers you in the long term.”
But if you’re just looking for easy money to use in frivolous ways instead of investing in either your home or other assets of value, avoid getting a HELOC.
“You’re selling part of your home to get a HELOC, and the interest rate on it will be higher than on your conventional mortgage, so reckless spending could cause you to lose your home if you’re unable to pay off your HELOC or mortgage,” Chen warned.
Build your financial future
As a homeowner, it’s great to know the answer to the question, “How much equity do I own?” Whether you use it to make a wise investment for the short term or save it to enable you to buy a more affordable home in the future, home ownership is a big part of your wealth picture. As with any investment, it pays to allow it to grow over time. The longer you live in your home, the more your home equity should grow.
Disclaimer: The above is intended solely for informational purposes and in no way constitutes legal advice or specific recommendations.